UK banks downgraded as stress test fears grow

RBS may need billions in extra capital as a result of new stress tests by European authorities

Signs that the Government has become less likely to support lenders led to another credit rating downgrade for Lloyds and Royal Bank of Scotland yesterday against the backdrop of concerns that new European stress tests could leave the sector in need of billions of pounds of extra capital.

The ratings agency Fitch lowered its credit score for both Lloyds and RBS to A from AA-minus, reflecting its view that "support dynamics are changing in the UK". Fitch also put Barclays on negative watch, meaning that it could be downgraded in the future.

"The banking system is not only large relative to the UK economy but there is also more advance political will to reduce the implicit support for the country's banks," Fitch said, citing the Vickers Commission's recommendations to ring-fence retail banks from riskier investment operations.

The move followed similar action by Fitch's rival agency Moody's last week, and came amid fears that RBS could end up needing billions in extra capital as a result of new stress tests by European authorities.

Officials are working on plans to recapitalise the banking system as they seek to protect it from the sovereign debt crisis. The European Banking Authority (EBA), which is studying capital needs at systemically important lenders, is expected to apply hefty discounts to the sovereign bond holdings to assess their ability to withstand the crisis. Reports suggest that it could also raise its threshold for what it considers an adequate capital cushion or core tier one capital ratio to 9 per cent.

With the details still being worked out, Credit Suisse analysts said that, based on the reports and after applying a tougher stress test than that applied by the EBA when it last studied balance sheets in the summer, RBS could need about €19bn (£16.5bn) in extra funds. Germany's Deutsche Bank and France's BNP Paribas could require up to €14bn each, while Société Générale and Barclays "would need roughly €13bn".

But the various moving parts – the final level of discounts on sovereign debt and the required capital ratio are still under discussion – mean that other analysts came to different conclusions. Evolution Securities, for example, said that UK banks had already done the heavy lifting by scrapping dividends and shrinking balance sheets, and did not require additional capital.

The analysis came as JosephAckerman, the chief executive of Germany's Deutsche Bank, warned: "It is not the capital position which is the problem but the fact that sovereign debt as an asset class has lost its risk-free status."